April 26, 2006
The Price of Oil Posted by John Steele Gordon at 03:15 PM EST Certain news events recur on a regular basis and the media always handle them the same way. The first warm, sunny day of spring is invariably recorded in the next day’s newspapers with pictures of people in shirtsleeves luxuriating on park benches and courthouse steps; heavy rains are followed by pictures of people leaping over street-corner puddles. Would anyone notice, or even be able to notice, if the video on television of the lighting of the Rockefeller Christmas tree every December was actually taken last year or a decade ago? (I’m told that since Japan is on the other side of the International Date Line, Japanese television has no choice but to use the previous year’s footage of the ball descending over Times Square every New Year’s Eve; no one seems to mind.) We are now in the midst of another recurring news story, and, once again, the coverage is much the same. Oil prices, and thus prices for everything made from oil—most noticeably gasoline—are very high right now, as they have been numerous times in the past. It cost me $43 to fill the tank of my modest Subaru the other day, so I hate to think what it must cost to fill up a Hummer. (Of course, even if gas were cheap, why anyone would want to drive around in a vehicle that looks, and, I’m sure, handles like a repainted Brink’s truck is one of the mysteries of human nature beyond my powers of understanding.) The media has handled the high-gas-price story as it always does, with man-in-the-street interviews in which the interviewees proclaim themselves economically devastated by this utterly unanticipated bolt from the blue and with interviews of politicians who see a dark conspiracy among the giant oil companies to push up prices and make “obscene profits.”
The one explanation never discussed, it seems, is the law of supply and demand. I would truly love it if just once a reporter confronted with a politician making the claim of oil-company collusion (which, of course, would be illegal) would say, “Senator, could you please explain why it is that while oil companies can conspire to push up prices, as you say they are doing now, they can’t seem to conspire to keep them up? For several years in the 1990s gas prices fell consistently until they reached levels not seen in real terms since the 1950s. What prevented the oil companies then from conspiring to raise prices and make obscene profits?” The fact of the matter is that crude-oil prices have been volatile since Edwin Drake brought in the first oil well in 1859, and the cost of crude oil is about 55 percent of the cost of gasoline. Production in the first decade of the oil industry soared more or less steadily upwards, from 2,000 barrels in 1859 to 4.5 million barrels 10 years later. But prices were all over the map, falling as low as 10 cents a barrel (well below the cost of the barrel) and reaching as high as $13.25. The Standard Oil Trust, which in its heyday controlled about 90 percent of the American oil industry, was able to reduce but not eliminate the volatility, but oil prices fell on average throughout the Standard Oil era.
The reason the price of this vital commodity is volatile is strictly Economics 101, a course no political reporter seems ever to have taken. Demand for oil has been rising more or less steadily over the last 150 years as industrialization has steadily increased. American consumption of petroleum, 4.5 million barrels in 1870, increased to 60 million barrels by 1900. Today we use that much petroleum every three days.
But supply rises only in fits and starts. Oil exploration is very expensive. Bringing discoveries on line is very expensive. New refineries to turn oil into gasoline are very expensive. In fact oil is one of the most capital-intensive businesses on the planet, and that capital must be committed years in advance of any return. That, naturally, makes people wary of investing until prices reach a high level. High price levels also spur conservation (leave the Hummer in the driveway, take the Volkswagen) and investment in alternative fuels and alternative sources. Serious money is already being put into developing the necessary technology to turn garbage into petroleum, which would be a win-win situation, with a 500-barrel-a-day plant already in operation in Missouri. (See http://www.discover.com/issues/may-03/features/featoil/ and http://www.discover.com/issues/apr-06/features/anything-oil/.) Indeed that’s exactly how the oil business got started. Rising demand for whale oil for light was fast depleting the world’s whales, sending prices through the roof. Self-interested entrepreneurs sought other illuminants, including kerosene from “rock oil,” as petroleum was then called (petroleum just means rock oil in Latin anyway). Edwin Drake proved that drilling could vastly increase the supply. One of the great industries of the modern world was born, and the whales got a much-needed reprieve, another win-win.
Capitalism will solve the problem of high oil prices a lot faster than bloviating senators.
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